U.K. pound’s post-Brexit plunge echoes past crises

Through­out the 20th cen­tury, Bri­tain en­dured a se­ries of cur­rency crises that ex­posed its de­cline as a ma­jor global power.

The re­cent slide in the pound ster­ling has reawak­ened mem­o­ries of those trou­bled times, in­clud­ing one in the mid-1970s when the coun­try ended up need­ing an in­ter­na­tional bailout.

And it has raised ques­tions of whether an­other so-called “ster­ling cri­sis” might push the govern­ment to soften its plans to break away from the European Union and its sin­gle mar­ket.

The pound has fallen by nearly a quar­ter against the dol­lar since the June 23 vote to leave the EU, from around $1.50 to a 31year low below $1.20. That scale of fall is equiv­a­lent to some of the great de­pre­ci­a­tions over re­cent decades, from 1949 through to 1992, that have caused up­heavals in govern­ment pol­icy and shaken the econ­omy.

Si­mon Der­rick, chief cur­rency strate­gist at BNY Mel­lon, said the cur­rent drop in the pound is so far echo­ing how pre­vi­ous cur­rency crises un­folded: “Given his­toric move­ments, it’s been very much busi­ness as usual.”

Though a weaker pound can boost ex­ports and help re­bal­ance the econ­omy from be­ing overly re­liant on con­sump­tion rather than trade and in­vest­ment, stan­dards of liv­ing in the coun­try could drop in com­ing months as in­fla­tion pushes higher. A weaker cur­rency makes im­ported food and other goods like fuel more ex­pen­sive and re­duces pur­chas­ing power abroad.

The pound’s drop has has­tened since new Prime Min­is­ter Theresa May in­di­cated that her govern­ment hasn’t ruled out a com­plete break from the EU sin­gle mar­ket, which could bring back ex­pen­sive tar­iffs for trade with the other 27 EU coun­tries, if that’s what is needed to limit im­mi­gra­tion.

So far, it seems May — like many of her pre­de­ces­sors at 10 Down­ing Street — is pre­pared to let the pound weaken as it helps cush­ion the im­pact of the Brexit shock on the econ­omy by boost­ing ex­ports. But there is a limit to what she and her govern­ment will be will­ing to en­dure.

Der­rick says that limit could be when the pound hits one-to-one with the euro or the dol­lar, some­thing that has never oc­curred with ei­ther cur­rency. At present, the pound is worth around $1.23 and 1.12 eu­ros.

“It (par­ity) will res­onate with a govern­ment that is still pretty fresh,” said Der­rick. “They will be well aware that crit­i­cism will start to mount.”

Should the pound drop to such lev­els over the com­ing months, in­fla­tion will likely pick up to rates that have a real im­pact on house­holds’ in­comes. And Bri­tish hol­i­day­mak­ers will, if they haven’t al­ready done so, see how much less their money buys them abroad — ef­fec­tively mak­ing them poorer.

It is these sorts of un­in­tended con­se­quences that have his­tor­i­cally got­ten gov­ern­ments con­cerned.

Of­fi­cial fig­ures this week showed the an­nual rate of in­fla­tion is run­ning at a near two-year high of 1 per­cent — even be­fore any no­table im­pact from the fall in the pound. Some an­a­lysts es­ti­mate it could hit 4 per­cent by 2018, which is dou­ble the Bank of Eng­land’s tar­get.

For Jane Fo­ley, chief cur­rency strate­gist at Rabobank In­ter­na­tional, the govern­ment is less likely to be con­cerned about the ab­so­lute value in the pound — un­less truly calami­tous — but rather con­tin­ued volatil­ity in the cur­rency. That would make it more dif­fi­cult for com­pa­nies to plan ahead.

“High lev­els of volatil­ity can have a detri­men­tal im­pact to the econ­omy,” Fo­ley said. “In some in­stances the size of a cur­rency’s move­ment may have greater rel­e­vance to pol­i­cy­mak­ers than its ac­tual value.”

The pound’s drop is evok­ing mem­o­ries of one of the most defining mo­ments in post-war Bri­tain, when in 1976 the then Labour govern­ment had to ap­proach the In­ter­na­tional Mon­e­tary Fund for a loan af­ter the cur­rency fell by a quar­ter to a then record low against the dol­lar.

In re­turn for the loan — at $3.9 bil­lion, it was the largest the IMF had ever made — the govern­ment had to change eco­nomic poli­cies and cut spend­ing and clamp down on wages. The pre­scrip­tion is the same as what Greece is be­ing forced to do to­day.

The episode trashed Labour’s rep­u­ta­tion for eco­nomic com­pe­tence and fos­tered the rise of the freemar­ket ide­ol­ogy and the rise to power in 1979 of Mar­garet Thatcher’s Con­ser­va­tive Party. But the Con­ser­va­tives also saw their rep­u­ta­tion for eco­nomic com­pe­tence dam­aged when in 1992 the pound was ejected from a fixed European ex­change rate sys­tem that was the pre­cur­sor to the euro.

One mit­i­gat­ing fac­tor to­day is that Bri­tain’s econ­omy ap­pears on the whole more able to with­stand a sim­i­lar drop in the pound. In 1976, for ex­am­ple, the price of oil had re­cently quadru­pled, send­ing in­fla­tion to around 25 per­cent. In­ter­est rates soared to 15 per­cent, com­pared to near zero to­day.

If the pound does drop more sharply, the Bank of Eng­land could be the first re­spon­der in any at­tempt to sta­bi­lize it.

BNY Mel­lon’s Der­rick doubts the govern­ment would re­quest that the cen­tral bank in­ter­vene di­rectly in the cur­rency mar­kets to prop up the pound by buy­ing it and sell­ing other cur­ren­cies. That’s partly be­cause the coun­try’s for­eign ex­change re­serves wouldn’t last for very long in to­day’s multi-tril­lion for­eign ex­change mar­ket.

But the Bank of Eng­land, which is in­de­pen­dent from govern­ment on set­ting in­ter­est rates, could look to tighten mon­e­tary pol­icy, such as by rais­ing in­ter­est rates, if it be­comes con­cerns about in­fla­tion ris­ing. That would likely sup­port the pound — higher rates tend to bol­ster a cur­rency.

There’s a catch. Higher rates would also fur­ther hurt the econ­omy and put pres­sure on house­holds by mak­ing mort­gages more ex­pen­sive.

THE AS­SO­CI­ATED PRESS

Con­ser­va­tive Party leader Mar­garet Thatcher holds up five one-pound notes dur­ing a speech April 30, 1976, in Finch­ley, North Lon­don. “Ev­ery time you spend five pounds,” she said, “the Govern­ment owes one to cred­i­tors abroad.” The pound has en­dured a sim­i­lar de­val­u­a­tion since the coun­try voted to leave the European Union in a ref­er­en­dum on June 23.